23 January 2007

Bits and Pieces of Data On Health Care Costs

In 1850 physicians had an average income of about $600 per year, only 248 percent of the average manufacturing worker's annual income. By 1900, physicians' annual incomes had risen to about $1250, still only 297 percent of the average manufacturing worker's annual income. Physicians' relative incomes continued to rise until by 1988 physicians' income had risen to $117,800 which represented 553 percent of an average manufacturing worker's yearly earnings.

Looking back since 1965, the history of payments to physicians under Medicare falls into three different periods. During the first period, from 1965 to 1984, physician fees were based on historical charges. With few constraints in place, it is not surprising that charges and volume increased substantially during this period. During the second period, from 1984 to 1991, fee growth was limited by the Medicare Economic Index. This period also experienced a rapid growth in spending.

The primary lesson learned over these first two periods was that controlling fees under a disaggregated fee schedule is not a very effective way to control or moderate spending on physician services. During these 25 years, spending for physician services grew more than 2.5 percentage points faster than spending for all services.

Legislation passed late in 1989 that introduced the concept of a resource-based relative value system, brought a series of changes to physician payment, leading to the third historical period, from 1991 to the present. These changes included:

Abandoning a charge-based system Limiting the liability that beneficiaries could face (that is, limiting balance billing by physicians) Redistributing physician payments Introducing explicit controls on volumeThe first volume-control mechanism was the volume performance standard, or VPS. It tied annual updates to physician spending relative to a target by impacting the conversion factor, which translated the relative values of the RBRVS to dollars. Over the next several years, however, problems primarily relating to unstable updates became increasingly apparent although the rates of increase in spending definitely declined. From 1992 to 1998, for example, the MEI varied from 2.0 percent to 3.2 percent, while the annual update varied from 0.6 percent to 7.5 percent.

The VPS was replaced by the SGR approach in 1997. It tied growth in the physician fee schedule to the growth in “real” (that is, inflation-adjusted) growth in the economy, per capita. The update now adjusts the MEI by the cumulative spending on physician services relative to the target. The problem is that since 2002 and for the next four years of the budget period, the update has been and is predicted to be a negative 4 percent to 5 percent.

Throughout the 1980s, Medicare's spending for physicians' services grew faster than its spending for all other services; in the 1990s, that trend reversed. From 1981 through 1990, spending for physicians' services grew at an average annual rate of 13.7 percent, whereas spending for all other services grew by 11.1 percent per year. By 1990, Medicare's total payments to physicians were more than three-and-a-half times greater than they had been 10 years earlier, and the average physician was receiving more than two-and-a-half times as much in Medicare payments. Indeed, the program's payments per physician increased almost twice as fast as did the nation's economy during the 1980s.

From May 5, 2004 testimony from Douglas Holtz-Eakin, Director, of the Congressional Budget Office.

Data on spending are readily available for 29 Organization for Economic Cooperation and Development (OECD) countries. In every one, medical spending has gone up significantly both in inflation-adjusted dollars per person and as a fraction of national income. In 1997, the United States spent 14 percent of gross domestic product on medical care, the highest of any OECD country. Germany was a distant second at 11 percent; Turkey was the lowest at 4 percent.

A key difference between medical care and the other technological revolutions is the role of government. In other technological revolutions, the initiative, financing, production, and distribution were primarily private, though government sometimes played a supporting or regulatory role. In medical care, government has come to play a leading role in financing, producing, and delivering medical service. Direct government spending on health care exceeds 75 percent of total health spending for 15 OECD countries. The United States is next to the lowest of the 29 countries, at 46 percent. In addition, some governments indirectly subsidize medical care through favorable tax treatment. For the United States, such subsidization raises the fraction of health spending financed directly or indirectly by government to more than 50 percent.

What are countries getting for the money they are spending on medical care? What is the relation between input and output? Spending on medical care provides a reasonably good measure of input, but, unfortunately, there is no remotely satisfactory objective measure of output.

Ultimately, the purpose of this article is to examine the situation in the United States. I have mentioned the data on the OECD countries primarily to document the two (related?) respects in which the United States is exceptional: we spend a higher percentage of national income on medical care (and more per capita) than any other OECD country, and our government finances a smaller fraction of that spending than all countries except Korea. . . .

Expressed as a fraction of national income, spending on medical care went from 3 percent of the national income in 1919 to 4.5 percent in 1946 to 7 percent in 1965 to a mind-boggling 17 percent in 1997. No other country in the world approaches that level of spending as a fraction of national income no matter how its medical care is organized. The changing role of medical care in the U.S. economy is truly breathtaking. To illustrate, in 1946, seven times as much was spent on food, beverages, and tobacco as on medical care; in 1996, 50 years later, more was spent on medical care than on food, beverages, and tobacco. . . .

The data document a drastic decline in output over the past half century. From 1946 to 1996, the number of beds per 1,000 population fell by more than 60 percent; the fraction of beds occupied, by more than 20 percent. In sharp contrast, input skyrocketed. Hospital personnel per occupied bed multiplied ninefold, and cost per patient day, adjusted for inflation, an astounding fortyfold, from $30 in 1946 to $1,200 in 1996. . . . Hospital days per person per year were cut by two-thirds, from three days in 1946 to an average of less than a day by 1996. . . .

Expected longevity went from 47 years in 1900 to 68 years in 1950, a truly remarkable rise. From 1950 on, expected longevity continued to increase but at a much slower rate, reaching 76 years in 1997. For our purposes, it is of fundamental importance that, whatever its source, the increase in longevity did not have any systematic relation to spending on medical care as a fraction of income. . . .

In terms of holding down cost, one-payer directly administered government systems, such as exist in Canada and Great Britain, have a real advantage over our mixed system. As the direct purchaser of all or nearly all medical services, they are in a monopoly position in hiring physicians and can hold down their remuneration, so that physicians earn much less in those countries than in the United States.

Data from the Medicare Payment Advisory Commis-sion and the Centers for Medicare & Medicaid Services(formerly the Health Care Financing Administration) (3,4) suggest that from 1991 to 2002, Medicare paymentrates for services provided by internists and family practitioners increased by 17% and 45%, respectively, relative topayment rates for all physicians. Payment rates for primarycare services, mainly office and hospital visits (but irrespective of the specialty of the physician) also increased by asubstantial amount in relation to payment rates for all physician services, probably in excess of 40%. . . .

Physician incomes have not kept up with inflation,presumably reflecting the expansion of managed carethroughout the 1990s. According to the American MedicalAssociation, inflation-adjusted physician incomes declined5% from 1991 to 1998 (5). Compared with inflation, in-comes of general internists and family practitioners in-creased by 2% and 8%, respectively (5).

The pressure on fees that came from the expansion ofmanaged care in the 1990s, along with the extensive use ofcapitation for primary care services, probably explains thelimited gains in income for primary care physicians.

The United States has long been the most expensive health system in the world, and it remains so today, even after a decade of "managed care." Table 1 shows the most recent available data on total national health spending in 1999, with the U.S. per-capita health spending ($4,358) and U.S. percentage of GDP spent on health care (13%) each set to 100%. The ranking for 1990 would have been quite similar. Several points may be noted in connection with this table.

First, with the exception of Canada, the populations of all other nations shown in the graph are much older than ours. To illustrate, only in the year 2020 will the percentage of the American population over age 65 reach the current German percentage, and only in 2025 will the American age structure reach Sweden’s current age structure.

Second, if one distinguishes between real health care services (physician visits, hospital days, drugs, supplies, and so on) and financial resources (spending), it is found that most of the nations shown in Table 1 actually devote more real resources overall per capita to health care than does the U.S. The U.S. does rank higher, however, in the availability and use of highly sophisticated medical technology.

Third, as is seen in Table 1, all other industrialized nations cede to the providers of health care (doctors, nurses, pharmaceutical manufacturers, etc.) a much smaller fraction of the nation’s GDP than does the U.S. The other nations can do this because the structure of their health insurance systems amasses monopsonistic (single-buyer) market power on the demand side of the market , which allows third-party payers to pay the providers of health care lower money prices for that care than they would have to pay under the more loosely structured U.S. system. It is the reason, for example, why prices for the same brand-name prescription drugs can be so much higher in the U.S. than in Canada and Europe, and why American physicians are much better paid than their colleagues abroad. On average, the net income of American physicians in 1999 was 5.5 times average employee compensation. The comparable numbers for Germany and Canada are 3.4and 3.2, respectively.

Fourth, the U.S. has by far the most complex and bureaucratic health-insurance system in the world. In an elaborate cross-national study of health spending in 1990 published in 1996, for example, the McKinsey Global Institute found that after all conceivable adjustments were made for demographic and other differences between nations, Germans in 1990 spent an average $390 more on health care proper than did Americans, while Americans spend $360 more on "administration" and another $256 more on "other" items not specifically identified by McKinsey, but probably including still other administrative overhead. There simply does not exist anywhere in the world a pluralistic health insurance system as complex, as paper hungry and as computer- and labor-intensive as is the American system.

Fifth, on most measurable, population-based health status indicators — e.g., life expectancy at birth or at age 65, infant mortality, preventable years of life lost — the U.S. always has ranked and continues to rank rather poorly relative to the rest of the industrialized world. Neighboring Canada, whose age structure is similar to ours, and which spends less than 60% of the comparable U.S. figure on health care per capita, ranks higher than the U.S. on all of these indicators.

Table 2 depicts the share of health spending paid by four groups of payers [from 1965 to 2000]: government, private insurance, other private third-party payer and patients, out of pocket. Some remarkable features stand out from the display. First, the share of health spending paid out of pocket by patients has decreased steadily over time, although it has remained stable since 1995. Out-of-pocket spending varies, of course, enormously among families. Second, private insurance now covers only a third of all health spending in the U.S., over 90% of it provided by employers at the place of work. Finally, governments at all levels combined now represent the major source of all health spending in the U.S. If one adds to the direct government payments shown in Table 2 the roughly $130 billion or so added taxes all taxpayers must pay annually to cover tax-revenues lost under the tax-preference accorded employer-paid health insurance premiums (these premiums are not added to the employee’s taxable income), then more than 60% of all U.S. health spending is now tax-financed. As a percentage of GDP, tax-financed health care in the U.S. now exceeds tax-financed health care even in the U.K., with its government-run health system.

Table 3 shows the time path of per-capita U.S. health spending, in constant (inflation-adjusted) dollars. It is seen that, from 1965 to about 1987, actual per-capita spending closely followed a trend line according to which the health sector asked and received from society, each year, 4.5% more real purchasing power per man, woman and child than it did before. By contrast, constant-dollar GDP per capita rose at a long-run average of only 1.7% per year over the same period.

[In 1965 per capita spending in health care in constant 2000 dollars was roughly $1,000, in 2000 it was roughly $6,000 per capita.]

From 1987 on, actual spending rose above the historic trend line. Most of the more rapid growth in spending originated in the private insurance sector, which then still paid each doctor, hospital, and other provider of health care more or less whatever they were billed, with few questions asked. By contrast, for Medicare patients, the Reagan administration had as early as 1983 imposed on the hospital a centrally administered system of price controls that imposed a common, uniform fee schedule for all hospitals in the entire nation. (Were this essay not addressed to Princeton alumni, one might properly call it a Soviet-style approach to hospital pricing). For his part, President Bush followed suit by imposed a nationwide, centrally set fee schedule similar with strict price controls on physicians in early 1992, along with a total global budget for all annual Medicare spending on physicians.

As a result of these tough price controls, Medicare spending per beneficiary during most of the 1980s actually rose much less rapidly than per-capita spending in the private sector. Indeed, private insurers and the employers behind them loudly complained that the annual premiums increases of 15% to 18% they suffered during the late 1980s were in good part the result of a "cost shift" from government to the private sector. The theory is that whenever government tightly controls health spending, the providers of health care simply increase the prices charged private payers or persuade their patients to use added health services.

The onset of managed care

The rapid escalation of employer-paid insurance premiums, coming as it did in the midst of the economics recession around 1990, set the stage for the onset of what has come to be known "managed care." At the core of this approach was the ability of private employers, during the recession, to force upon their anxious employees health insurance products that limited the employees’ choice of providers to defined networks, which often limited direct access to medical specialists, and which sometimes limited patients’ access to new and expensive medical technology — e.g., to new, expensive brand-name medicines. Employees accepted these novel strictures at the time, because they worried more about keeping their jobs than about the design parameters of the health-insurance policy that came with the job.

These limitations of choice enabled the health insurance companies that were writing these policies to contract selectively with physicians, hospitals, pharmacies, and other providers for the health care owed the insured. Selective contracting, in turn, converted these providers of health care into fiscally dependent subcontractors of particular health plans. The plans could impose serious fiscal hardship on individual providers, simply by canceling their contracts with the plan. That fiscal dependence, and the constant economic threat it implied, enabled the health plans to extract from the providers of health care steep price discounts. It also enabled the health plans to impose upon providers clinical practice guidelines that determined whether or not a health plan would pay for particular services rendered. Altogether, these novel relationships among insurance plans, on the one hand, and the providers of health care and their patients, on the other, constituted the phenomenon properly called "managed care."

As is shown in Table 3, the attempt to control American health spending through the techniques of "managed care" did bend the time path of actual real per-capita health spending during the period 1992-97 below the long-run spending trend line. During the mid 1990s, real per-capita health spending rose at rates much below the historical long-run average of 4.5%. The health insurance premiums charged employers for their group policy rose at ever smaller annual rates, reaching an average of a zero increase in 1996. The percentage of GDP spent on health care was virtually constant, hovering about 13.5%. In 1993 Congressional Budget Office (CBO) had projected that health spending in the year 2000 would be $1.67 trillion, or close to 20% of the GDP. The actual number for 2000 turned out to be $1.3 trillion, or only about 13% of GDP.

Economic theory suggests that, in the tight labor markets of the 1990s, the bulk of these savings in health spending are likely to have flown through to employees in the form of higher take-home pay. That theory, however, is not widely shared among non-economists. A more popular theory in the press, and especially among the providers of health care, is that these savings reflect the denial of needed care to the insured and that they flowed mainly into the bottom line of employers and the paychecks of health insurance executives. The "managed care" backlash unleashed by physicians, politicians, and the media was driven by this popular theory.

Starting in 1997, with "managed care" in wholesale retreat, overall average real per capita health spending in the U.S. has been rising once again, at an ever-accelerating pace. As is seen in Table 1, it now proceeds at roughly the same high growth rate that was experienced during the late 1980s—albeit still below the long-run historical trend line. For the 2001-2002 season, these increases are projected to be in the mid- to high double digits, even for large employers, and in excess of 20% for small employers and individuals.

Per capita health spending under the public Medicare and Medicaid programs currently are still rising at much lower rates than those in the private sector, partly as a result of cost-control measures legislated in the late 1990s. It is only a matter of time until these public programs must adapt to the prices and spending levels set by the private sector. Furthermore, just as in the later 1980s, private insurers and employers are convinced once again that the tighter control of government health spending shifts costs to private payers. Therefore, they will lobby the Congress to relax the reins on public health spending. In short, the health-care cost crisis of the late 1980s has returned to the U.S. in full bloom.

From Uwe Reinhardt, "How healthy is our health care", Princeton Alumni Weekly, April 10, 2002 (I am generous in excerpting from this article on the theory that the author, a tenured professor of economics at Princeton, likely is more concerned about getting the facts out to influence policy than about economic compensation for the article.)

A report planned for release today indicates that the average physician's net income declined 7 percent from 1995 to 2003, after adjusting for inflation, while incomes of lawyers and other professionals rose by 7 percent during the period.

The researchers who prepared the report say the decline in doctors' inflation-adjusted incomes appears to be affecting the types of medicine they choose to practice and the way they practice it — resulting in fewer primary care doctors and a tendency to order more revenue-generating diagnostic tests and procedures.

Primary care doctors, who are already among the lowest-paid physicians, had the steepest decline in their inflation-adjusted earnings — a 10 percent drop — according to the report by the Center for Studying Health System Change, a nonprofit research group in Washington.

The average reported net income for a primary care physician in 2003 was $146,405, according to the study, after expenses like malpractice insurance but before taxes. The highest-paid doctors were surgeons who specialize in areas like orthopedics, who had an average net income of $271,652, nearly double what the primary care doctors said they earned.

The report was based on a national telephone survey of roughly 6,600 physicians in 2004 and 2005 and earlier surveys by the research center. . . .

While the general inflation rate was 21 percent during the period, payments from Medicare rose only 13 percent, according to the study, and payments from private insurers rose even more slowly.

The average physician earned almost 4% less in 1994 than in 1993. . . . Since 1982 when statistics were first collected, up until 1994, median physician income had risen at an average annual rate of 5.9 percent in nominal terms, and 2.1 percent in inflation-adjusted dollars.

From 2000 to 2004, average inflation-adjusted nursing salaries went up by 12.8%. That’s real salary, not nominal, folks. Salaries for teachers and nurses were about equal in 1986. Now full-time nurses average $60,000 annually, while teachers make about $48,000. In fact, over the last 20 years, registered nurse salaries have risen faster than teachers, professors, architects, engineers, ubiquitous lawyers, even physicians.

A chart in the same source shows that physician pay rose 34% from 1986-2005 and that pay for nurses rose 36.2% in that time period. In the same time period lawyers saw an 18% increase in pay, teachers 6.1%, engineers and architects 5.0%, and academia 0.3%.

These are among the findings of the Department of Labor's 2004 National Compensation Survey, which was released this month and reports hourly wages across more than 450 occupations covering 81 million workers. . . .

[T]he average hourly pay for pilots was $113.82 last year, up 15.6% from 2003 and the highest for any job category measured. Economics professors . . . came in second, with average hourly pay of $63.98, up 1.9% from 2003. In third place were medical doctors, with average hourly pay of $57.90 last year, up 9.4% from 2003. . . .

The Wall Street Journal asked Economy.com, an economic consulting firm in West Chester, Pa., to compare the results of the 2004 National Compensation Survey with the 1997 survey and to compute changes in wages, adjusting for inflation. . . .

The shortage of nurses, coupled with the aging and ailing population, pushed nurses' wages up 14% during the period, to an average hourly rate of $26.87. . . .

Dental hygienists is another category of health-care worker who have registered strong hourly wage gains, despite the fact that their average annual pay has trailed inflation since they are working fewer hours. Their average hourly wage was up an inflation-adjusted 30% for the seven-year period that ended in 2004, and now stands at $30.86. The climb has narrowed the salary gap between hygienists and dentists, whose average hourly salary fell an inflation-adjusted 3% during the period despite the fact that from 2003 to 2004, dentists' wages were up 7% after inflation to $42.91.

The table shows an inflation adjusted increase of 33.3% for physicians from 1997 to 2004.

The rising share of U.S. gross domestic product (GDP) devoted to health care has been well documented and often lamented. Growth in health care spending appears to have recently accelerated after a slowdown in the mid- and late 1990s. In fact, for most of the post–World War II period, inflation-adjusted health care costs rose at a much faster rate than did GDP. To illustrate, between 1945 and 1998 the growth rate in real per capita national health care spending averaged 4.1 percent, compared with a 1.5 percent increase in GDP. Moreover, for every ten-year period between 1945 and 1998, spending on health care grew at a rate faster than that of income. Although some increase in health spending would be expected solely from the aging of the U.S. population, evidence suggests that historically, changing demographics have accounted for only a small fraction of the gap between the growth of real health care spending and GDP. . . .

[I]n the 1980s (the decade that saw the highest share of income growth spent on health care), real health care spending per capita rose by nearly 70 percent, but this growth consumed only about one-quarter of the increase in real income per capita. That is, the substantial growth in health spending during the 1980s did not prevent three-quarters of real income growth from being spent on goods other than health care.

The first set of results assumes that real per capita national health care spending rises one percentage point faster than real per capita GDP, before accounting for demographic changes. The second set assumes that the differential is two percentage points, again before adjusting for demographic changes.

One-percentage-point gap. Under the one-percentage-point-gap assumption, which matches what the technical review panel recommended and what was adopted by the Medicare trustees as the base scenario, spending on non–health care goods and services continues to rise throughout the seventy-five-year period. Even between 2050 and 2075, about 35 percent of the forecasted increase in per capita GDP remains available for increased spending on non–health care products. By 2075 health care represents 38 percent of GDP. . . . the share of income growth devoted to health care is quite high by historical norms. The highest percentage devoted to health care in any of the past four decades (25.3 percent in the 1980s) is lower than the projected percentage in the 1999–2010 period (30.9 percent).

Further, the projected percentage of income growth consumed by health spending continues to rise after 2010. This suggests that should health care costs continue to grow even at this seemingly conservative rate, it would represent a major break with historical norms in terms of the share of income growth devoted to health care. . . .

Two-percentage-point gap. The two-percentage-point assumption, which is closer to the historical gap between health care spending growth and GDP growth, reveals a greater burden on the economy. Through 2039 spending on non–health care goods and services continues to grow, but at a much slower rate (Exhibit 4). About two-thirds of the increase in per capita income between 2010 and 2040 is devoted to health care.

The period between 2040 and 2075 exhibits a drop in spending on non–health care goods and services (which would not be affordable according to the definition adopted by the technical review panel). Under this scenario, per capita non-health spending drops to 1999 levels around 2062. By 2075 the rise in health care spending has reduced nonhealth spending to about 60 percent of current levels, which suggests that a two-percentage-point differential would not be sustainable by the second half of this century.

In 2004 (the latest year data are available), total national health expenditures rose 7.9 percent -- over three times the rate of inflation (1). Total spending was $1.9 TRILLION in 2004, or $6,280 per person (1). Total health care spending represented 16 percent of the gross domestic product (GDP). . . .

In 2006, employer health insurance premiums increased by 7.7 percent - two times the rate of inflation. The annual premium for an employer health plan covering a family of four averaged nearly $11,500. The annual premium for single coverage averaged over $4,200 (3). . . .

Although nearly 47 million Americans are uninsured, the United States spends more on health care than other industrialized nations, and those countries provide health insurance to all their citizens (4).

Health care spending accounted for 10.9 percent of the GDP in Switzerland, 10.7 percent in Germany, 9.7 percent in Canada and 9.5 percent in France, according to the Organization for Economic Cooperation and Development (5). . . .

Premiums for employer-based health insurance rose by 7.7 percent in 2006. Small employers saw their premiums, on average, increase 8.8 percent. Firms with less than 24 workers, experienced an increase of 10.5 percent (3)

The annual premium that a health insurer charges an employer for a health plan covering a family of four averaged $11,500 in 2006. Workers contributed nearly $3,000, or 10 percent more than they did in 2005 (3).The annual premiums for family coverage significantly eclipsed the gross earnings for a full-time, minimum-wage worker ($10,712).

Workers are now paying $1,094 more in premiums annually for family coverage than they did in 2000 (3).

Since 2000, employment-based health insurance premiums have increased 87 percent, compared to cumulative inflation of 18 percent and cumulative wage growth of 20 percent during the same period (3). . . .

According to the Kaiser Family Foundation and the Health Research and Educational Trust, premiums for employer-sponsored health insurance in the United States have been rising four times faster on average than workers' earnings since 2000 (3).

The average employee contribution to company-provided health insurance has increased more than 143 percent since 2000. Average out-of-pocket costs for deductibles, co-payments for medications, and co-insurance for physician and hospital visits rose 115 percent during the same period (7).

The percentage of Americans under age 65 whose family-level, out-of-pocket spending for health care, including health insurance, that exceeds $2,000 a year, rose from 37.3 percent in 1996 to 43.1 percent in 2003 - a 16 percent increase (8). . . .

National surveys show that the primary reason people are uninsured is the high cost of health insurance coverage (9).

One in four Americans say their family has had a problem paying for medical care during the past year, up 7 percentage points over the past nine years. Nearly 30 percent say someone in their family has delayed medical care in the past year, a new high based on recent polling. Most say the medical condition was at least somewhat serious (13).

According to the national health spending estimates from the Center for Medicare and Medicaid Services (CMS), the administrative costs, taxes, profits, and other non-benefit expenses of private health plans have averaged about 12 percent of premiums over the last 40 years. This includes all types of health insurance purchased privately, ranging from employer-based coverage to individually purchased plans, Medigap and long-term care insurance. (These figures do not include private health plans operating in Medicare or Medicaid.) . . . .

Single-payer health reform advocates tout Medicare's low administrative cost rate, which was estimated by CMS to be 3 percent in 2003. However, it is particularly difficult to compare the reported administrative costs of Medicare with those of private health insurance plans.

First, Medicare's "capital costs" are not included in government estimates of Medicare spending. Here is a simplistic, but revealing example: federal net interest payments to the public -- the government's overall capital cost -- totaled $160 billion in fiscal year 2004. In that year, Medicare benefits (net of premiums collected from beneficiaries) comprised about 12 percent of federal non-interest spending. Therefore, Medicare's share of the government's debt-service costs could be estimated at about $19 billion in 2004. Adding these payments alone would boost Medicare's administrative cost rate by almost 7 percentage points, to just under 10 percent.

Second, Medicare's "benefit cost per claim" is likely higher than that of private plans serving the non-elderly population. However, high-cost claims can be just as easy to process as smaller claims. For example, it might cost $50 to process either a $5,000 claim or a $1,000 claim. If Medicare's claims-paying methods were applied to a younger population with lower benefit costs per claim, its reported administration rate would be higher simply because the "denominator" -- the overall claims cost -- was smaller.

Third, many private health plans allocate costs from their health improvement and care management efforts to "administration," not "benefits." Yet these initiatives can have a powerful payoff in improved health and reduced overall claims costs. For example, if Medicare's new disease management programs succeed at reducing expensive claims, Medicare's reported administrative cost rate would rise. (Administrative costs to implement disease management programs and evaluate outcomes would go up, but overall costs -- the denominator again -- would be lower.)

The accompanying table shows a range of 9% to 16% from 1960 to 2005, with no clear trend over time and cites CMS Office of the Actuary, January 2005 as the source. It claims a 40 year average of 12.4% and a current level of 14-15%.

Administrative costs account for 25 percent of health care spending, but little is known about the portion attributable to billing and insurance-related (BIR) functions. We estimated BIR for hospital and physician care in California. Data for physician practices came from a mail survey and interviews; for hospitals, from regulatory reporting; and for private insurers, from a consulting company. Private insurers spend 9.9 percent of revenue on administration and 8 percent on BIR. Physician offices spend 27 percent and 14 percent, and hospitals, 21 percent and 7–11 percent, respectively. Overall, BIR represents 20–22 percent of privately insured spending in California acute care settings.